Jason Ackerman is the management accountant for Central Restaurant Supply (CRS. Beth Donaldson, the CRS sales manager, and Jason are meeting to discuss the profitability of one of thecustomers, Mama Leone's Leone's Pizza. Jason hands Beth the following analysis of Mama Leone's activity during the lastquarter, taken from Central activity-based costing system:

Sales $23,400

Cost of goods sold (all variable) 14,025

Order processing (25 orders processed at $300 per order) 7,500

Delivery (2,500 miles driven at $0.75 per mile) 1,875

Rush orders (3 rush orders at $165 per rush order) 495

Sales calls (3 sales calls at $150 per call) 450

Operating income $ (945)

Beth looks at the report and remarks, "I'm glad to see all my hard work is paying off with Mama Leone's. Sales have gone up 10 % over the previous quarter!"

Jason replies, "Increased sales are great, but I'm worried about Mama Leone's margin, Beth. We were showing a profit with Mama Leone's at the lower sales level, but now we're showing a loss. Gross margin percentage this quarter was 40 %, down five percentage points from the prior quarter. I'm afraid that corporate will push hard to drop them as a customer if thingsdon't turn around."

"That's crazy," Beth responds. "A lot of that overhead for things like order processing, deliveries, and sales calls would just be allocated to other customers if we dropped Mama Leone's. This report makes it look like we're losing money on Mama Leone's when we're not. In any case, I am sure you can do something to make its profitability look closer to what we think it is. No one doubts that Mama Leone's is a very good customer."

Requirements

Assume that Beth is partly correct in her assessment of the report. Upon further investigation, it is determined that 10 % of the order processing costs and 20 % of the delivery costs would not be avoidable if CRS were to drop Mama Leone's. Would CRS benefit from dropping Mama Leone's? Show your calculations.

Beth's bonus is based on meeting sales targets. Based on the preceding information regarding gross margin percentage, what might Beth have done last quarter to meet her target and receive her bonus? How might CRS revise its bonus system to addressthis?

Should Jason rework the numbers? How should he respond to Beth's comments about making Mama Leone's look moreprofitable?

Solution

Requirement 1. Assume that Beth is partly correct in her assessment of the report. Upon further investigation, it is determined that 10 % of the order processing costs and 20 % of the delivery costs would not be avoidable if CRS were to drop Mama Leone's. Would CRS benefit from dropping Mama Leone's? Show your calculations. (Enter losses in revenues as a negative amount. If the net effect is an operating loss enter the amount with parentheses or a minus sign.)

Difference: incremental (loss

in revenues) and savings in costs

from dropping Mama Leone's

Revenues $(23,400)

Cost of goods sold 14,025

Order processing 6,750

Delivery 1,500

Rush orders 495

Sales calls 450

Total costs $23,220

Effect on operating income (loss) $(180)

CRS's operating income will be $180lowerif it discontinues Mama Leone's orders; therefore, CRSshould notdiscontinue Mama Leone's orders.

Requirement 2. Beth's bonus is based on meeting sales targets. Based on the preceding information regarding gross margin percentage, what might Beth have done last quarter to meet her target and receive her bonus? How might CRS revise its bonus system to address this?

The drop in gross margin percentage indicates that Bethmay be giving Mama Leone's excessive discounts. If CRS awards bonuses based on sales rather than some measure of operating income, it may encourage sales representatives tolower margins in order to increase sales. CRS may want to consider basing bonuses oncustomer marginand enforcemorestringent discounting guidelines.

Requirement 3. Should Jason rework the numbers? How should he respond to Beth's comments about making Mama Leone's look more profitable?

Jasonshould notrework the numbers. If the orders were placed less frequently, the companywould reduce both order processing and delivery costs.Jason should consider the request of Beth Donaldson to beunethical.Jason should indicate to Beth that thecosts he has derived are correct.If Beth insists on changing costs to serve Mama Leone's Pizza, Jason shouldcontact Beth's superior.